What’s Next for RBS’s U.S. Trading Arm?

The Royal Bank of Scotland will announce results next Thursday, but RBS Securities is unlikely to get much of a mention.

Reuters

RBS Securities, the bank’s U.S. trading business, was mentioned only four times in RBS’s 543-page annual report for 2012. The business, formerly known as Greenwich Capital and tucked away in Stamford, Conn., is rarely discussed in polite circles. It’s hardly ever written about.

And yet the decisions that Ross McEwan, RBS’s group chief executive, will soon have make about the business could play a key role in deciding the future shape of the whole group.

Why is RBS so coy about one of its biggest revenue generators, a division that employs a significant number of highly-paid staff? Why is RBS Securities so strategically pivotal? And if it is shed amid a grand scaling-back of the RBS’s investment bank as part of Mr. McEwan’s plans to “run the best bank in the U.K.”, what would the group really lose?

The New England-based business has played a central role in both the rise and fall of RBS. Greenwich Capital Markets was acquired by National Westminster Bank in 1996; NatWest was, in turn, bought by RBS in 2000. During the debt-driven bull years that followed, Greenwich prospered–fueling RBS’s acquisitive zeal.

It then helped the bank dive headlong into the collateral debt obligations market in 2006.

That caused many of the U.K. bank’s woes, but the Greenwich business quickly recovered. In 2011, RBS’s investment bank (then called global banking and markets) made 36% of its money in the U.S. (compared to only 27% in the U.K.), according to an investor presentation in March 2012. These are the most up-to-date figures available.

The awkwardness comes in how that money was made.

Of the $3.4 billion in revenues generated by RBS in the U.S. in 2011, only $640 million came from banking and $2.8 billion by RBS Securities. Of that, the majority ($1.5 billion) was made trading asset-backed products. In other words, as recently as two years ago, RBS’s investment banking division was making more money dealing in asset-backed (including mortgage-backed) products in the U.S. than almost anything else–not a situation likely to delight its largest shareholder, the U.K. government. Earlier this month, RBS agreed to pay $275 million to settle a U.S. lawsuit that claimed it misled investors who bought mortgage-backed securities.

No wonder the bank likes to keep this particular light hidden under a bushel.

First, the New Zealander must decide between two political imperatives: turning RBS into an ultra-orthodox, U.K.-focused bank or increasing the share price to a point where the U.K. government can sell off its stake. Are those two aims mutually exclusive? Not totally, but getting rid of the U.S. trading business would almost certainly delay the day when U.K. taxpayers get (at least some of) their money back.

Next, what kind of wholesale banking capability does Mr. McEwan want to maintain? Despite everything, RBS still boasts the most profitable corporate banking franchise in the U.K. But if RBS wants to provide a full range of services to those corporate customers, it needs a markets business. And if it wants to maintain a markets business, it needs—as lots of other European banks have recently acknowledged—a strong foothold in the U.S.

Even if Mr. McEwan decides to sacrifice RBS Securities, he’ll face yet more tough decisions. Should RBS want to retain, say, some foreign exchange and simple derivatives capability, it will have to start teasing apart the various strands of the markets business. This could end up making the U.S. trading unit a less attractive proposition to prospective buyers.

But even that’s not likely to top potential buyers’ concerns. As a business, it requires a lot of capital to meet regulatory requirements.

Mike Trippitt, banks analyst at Numis Securities, said: “When banks are under pressure to build up capital and to preserve capital, if you’re trying to come up with a list of buyers you’ll have a relatively short list.

“Who is going to write out that size check at the moment for that sort of business? Which chief executive is going to convince their board, even though it’s a great business, to make that kind of acquisition in this environment. It is quite tricky.”

One thing’s for certain: Mr. McEwan is really going to be earning that bonus he’s already turned down.

It appears likely he’ll announce some retrenchment next week. However, at least half of the job cuts outlined in newspaper reports Friday morning are already accounted for by the planned sale of Citizens, the bank’s U.S. retail arm, and the listing of its Williams & Glyn business, a network of several hundred U.K. bank branches, both announced last year, according to a note written by Citigroup analysts this morning.

What we’re less likely to hear—still—is any news on what’s happening to RBS Securities, according to a source familiar with the bank.